Euro area yields drop after US-EU deal, investors push back rate cut bets

By Stefano Rebaudo

July 28 (Reuters) - Euro area government bond yields edged down on Monday after a U.S.-EU trade agreement largely met economists’ expectations, while investors assessed their bets on European Central Bank monetary easing.

Markets saw an additional 25-basis-point rate cut as likely, but pushed back the timing, assigning a 65% probability for the move by December and an 85% chance by March 2026.

Expectations of a tariff deal and a hawkish tilt from the ECB had prompted investors to scale back bets on future cuts last week, pricing in a 60% chance of an easing move in 2025.

ECB policymakers appeared to temper market bets on no more rate cuts the day after Thursday's central bank meeting.

Some economists challenged the hawkish interpretation of remarks by ECB President Christine Lagarde, suggesting that her comments were more balanced and data-dependent than perceived.

“We disagree with the hawkish take,” BofA economist Ruben Segura-Cayuela said.

Markets are pricing an ECB depo rate at 1.84% by December EURESTECBM3X4=ICAP - implying a 65% chance of a rate cut by December - from 1.78% before the ECB statement on Thursday.

They indicated a depo rate at 1.73% early last week, before a U.S.-Japan trade deal helped ease fears over the recessionary impact of a trade war.

The deal was broadly in line with expectations set out last week and took the scenarios of ‘no deal’ or an immediate hike in tariffs off the table.

Some economists had argued that the deflationary impact of an average 30% tariffs - the rate U.S. President Donald Trump had threatened to impose without a deal - could have prompted the ECB to cut its deposit rate to 1.5% from the current 2%.

“Mutually disruptive escalation and retaliation between two global trade heavyweights will be avoided,” Mark Wall, chief euro area economist at Deutsche Bank, said.

Germany’s 10-year government bond yield DE10YT=RR, the euro area’s benchmark, was down 3.4 bps at 2.683%, after rising more than 10 bps in the last two sessions.

Investors are cautious at the start of a week packed with central bank policy meetings — including at the Federal Reserve and the Bank of Japan — and key economic data releases from the U.S. and the euro area.

The Bank of Japan is set to hold off raising interest rates on Thursday but may signal rate hikes later this year, after Tokyo's trade agreement.

U.S. President Donald Trump said on Friday he had a good meeting with Fed Chair Jerome Powell and got the impression that the head of the U.S. central bank might be ready to lower rates.

Markets expect rates unchanged at this week’s meeting.

German 2-year yields DE2YT=RR – more sensitive to expectations for ECB policy rates – fell 3.5 bps to 1.895%.

Italy’s 10-year government bond yields IT10YT=RR were down 5.5 bps at 3.527%, with the yield spread between BTP and safe-haven Bunds at 84.3 bps, near its lowest since March 2015.